Euro Area Money Demand: Measuring the Opportunity Costs Appropriately

Joaquim Levy, Alessandro Calza and Dieter Gerdesmeier

No 2001/179, IMF Working Papers from International Monetary Fund

Abstract: The existence of a well-specified and stable relationship between money and prices has long been perceived as a prerequisite for the use of monetary aggregates in the conduct of monetary policy. This paper contributes to the ongoing discussion about the stability of euro area money demand by constructing an own rate of return on euro area M3 and by analyzing its implications in a standard money demand system. Over the sample period, one cointegrating vector relating real M3, real GDP and the spread between the short-term interest rate and the own rate of M3 can be identified and interpreted as a long-run euro area money demand equation. A dynamic money demand system is subsequently estimated. Standard diagnostics stability tests and out-of-sample forecasts confirm the good statistical performance of the model.

Keywords: WP; money demand; interest rate; M3; opportunity cost; European Monetary Union; own rate of money; cointegration; demand model; GDP deflator; opportunity costs of money; long- term interest rate; money demand function; money demand system; interest-rate bearing; Demand for money; Short term interest rates; Market interest rates; Long term interest rates; Yield curve; Europe (search for similar items in EconPapers)
Pages: 38
Date: 2001-11-01
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Citations: View citations in EconPapers (129)

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